U.S. flag

An official website of the United States government

Department of Labor Logo United States Department of Labor
Dot gov

The .gov means it's official.
Federal government websites often end in .gov or .mil. Before sharing sensitive information, make sure you're on a federal government site.

Https

The site is secure.
The https:// ensures that you are connecting to the official website and that any information you provide is encrypted and transmitted securely.

Beyond BLS

Beyond BLS briefly summarizes articles, reports, working papers, and other works published outside BLS on broad topics of interest to MLR readers.

September 2024

One eye on U.S. coffers, one eye on their own: foreign policy rates and U.S. debt

Summary written by: Harry Nitzberg

In the 14 years between the end of the global financial crisis in 2008 and the end of 2022, U.S. federal government debt rose by 78 percent. This increase has prompted some scholars to suggest that the relationship between U.S. fiscal and monetary policy has become characterized by “fiscal dominance.” Fiscal dominance occurs when monetary policy is increasingly forced to accommodate growing fiscal deficits and government debt. This accommodation may take the form of using policy tools to suppress interest rates (thus lowering the cost of borrowing for the government) or printing more money to cover deficits. Although fiscal dominance has been examined in domestic contexts, there has been little research on whether it can occur in an international context.

In their paper, “International spillovers of U.S. fiscal challenges” (National Bureau of Economic Research, Working Paper 32868, August 2024), Joshua Aizenman, William Eldén, Yothin Jinjarak, Gazi Salah Uddin, and Frida Widholm investigate the spillover effects of U.S. government debt on the target interest rates (policy rates) of foreign central banks. The authors hypothesize that, because of the strong interconnectedness of the global economy and the dominance of the U.S. dollar in international trade, higher debt levels in the United States lead foreign central banks to keep their target rates lower. 

To measure U.S. fiscal dominance, the authors create a “U.S. fiscal dominance index” composed of indicators of U.S. debt levels (such as public debt as a percentage of gross domestic product (GDP) and government expenditure as a percentage of GDP). Complimentarily, they use the target rates of foreign central banks as the main dependent variable. The results show that, as the U.S. fiscal dominance index increased, the target rates of foreign central banks tended to decrease. Moreover, the majority of the models in the paper show that this spillover effect was stronger for developed economies (DEs) than emerging market economies (EMEs). The difference is partly explained by greater central bank independence and exchange rate stability in DE countries. These two attributes give DEs more credibility, providing their central banks with more flexibility in setting policy rates.

The authors then check to see if the relationship between the U.S. fiscal dominance index and foreign central banks target rates was constant over time. After graphing the U.S. fiscal dominance index over time, the authors notice a considerable spike after the 2008 financial crisis. To test whether the spillover effect on foreign policy rates was strengthened by the crisis, the authors add a variable to isolate the combined effect of the financial crisis and the U.S. fiscal dominance index. After the crisis, U.S. debt levels had a greater effect on the policy rates of central banks in DEs than before the crisis. By contrast, the crisis seemed to have no effect on the strength of the spillover effect on central bank policy rates in EMEs. Taken together, the authors’ findings suggest that, in a world of growing interconnectedness and government debt, central bankers must closely watch not just their government’s checkbook, but their neighbors’ as well.